Money, Prices, and Coordination Failures: (Late) Thursday Focus for August 14, 2014

The extremely-sharp Nick Rowe continues to elaborate his monetarist take on the foundations of macroeconomics:

Nick Rowe: Worthwhile Canadian Initiative: Money, prices, and coordination failures: “The symptom that is the identifying signature of a recession, and that explains those other symptoms…

…is that it becomes harder than normal to sell other goods for money and easier than normal to buy other goods for money. Shouldn’t anyone looking at that symptom immediately ask what is special about money… this year?….

Walras’ Law says that if you have a $1 billion excess supply of newly-produced goods, you must have a $1 billion excess demand for something else. And that something else could be anything. It could be money, or it could be bonds, or it could be land, or it could be safe assets, or it could be… anything other than newly-produced goods. The excess demand that offsets that excess supply for newly-produced goods could pop up anywhere. Daniel Kuehn called this the “Whack-a-mole theory of business cycles”. If Walras’ Law were right, recessions could be caused by an excess demand for unobtanium…. If you want to buy more unobtanium, or bonds, or land, or safe assets, or whatever, than you are actually able to buy, there is nothing you can do about it. And if you suddenly stopped wanting to buy more unobtanium than you were able to buy, nothing would change. If you want to buy more money than you are actually able to buy, there is something you can do about it. You can sell less money, and get to have more money that way instead…. An excess demand for unobtanium/bonds/land/safe assets/whatever doesn’t matter. If people stopped wanting to have more unobtanium than they actually had, nothing else would change…

I have to say that most of what I have quoted from Nick seems wrong to me. Yes, in 1982-1983 it was true to say “it became harder than normal to sell other goods for money and easier than normal to buy other goods for money”–we saw the prices of all currently-produced goods and services slump below their previously-expected values, and the prices of all financial and other capital assets slump as well. But this was not true in 2008-9: then there was definitely a downturn, and yet it did not become harder but easier to sell U.S. Treasury bonds–and other debts of reserve currency-issuing sovereigns–for cash. The prices of safe interest-yielding assets spiked, and spiked high. Not what you would expect if the problem were properly and fully characterized as an excess demand for liquid cash money, no?

And it is also not true today. Today there is definitely a downturn: it is still much harder than usual or than previously expected to sell your labor and to make and sell currently-produced goods and services for money. But not just safe interest-yielding assets but a whole host of assets from Treasury bonds to coastal real estate to corporate bonds and even risky equities command premium prices: it is easier than usual or than previously expected to sell them for cash. That is why I get a flyer a week now from a real estate agent pointing out how incredibly easy it would be to sell my Berkeley, CA house for cash–and how much cash I could get. Once again, not what you would expect if the problem were properly and fully characterized as an excess demand for liquid cash money, no?

And if the problem is not properly and fully characterized as an excess demand for liquid cash money, why is printing up more liquid cash money being sold by Nick and his karass as a full and complete solution?

Nick does have a fallback position:

A worsening of asymmetric information problems in financial markets, which is a coordination problem in its own right, also causes an increased demand for money and a monetary coordination problem. Should we say that the problem in financial markets is the “root cause” of the recession, and one that should be addressed directly, if possible, by something other than monetary policy? No. Monetary policy should take the world as it is, warts and all, and do what it can do…. It does not matter, for the monetary authority, whether that increased demand for money was caused by some natural event like the weather, which nobody can change, or whether it was caused by some other problem, which the fiscal authority can and should fix…

Perhaps it would be better to say that our highly-complicated and finely-divided societal division of labor runs on markets and trust. You have to trust when you sell goods and services for future consideration that your counterparty will deliver. You have to trust it when you provide consideration and buy goods and services for future delivery that what will be delivered is as specified. Without that trust, it does not work. Without money and without contract law, the extent of the division of labor that we can directly access is limited to our circle of trust: our kin, our neighbors, and our close friends–and only the subsets of those whose word we have confidence is good. Money and contract law are both ways of expanding this circle of trust, but they do so in different ways, and they do so imperfectly.

But as long as Nick Rowe recognizes that fixing situations of depressed activity by simply printing money gets us not to the first-best but the second-best in many situations, I can have no quarrel. But if Nick Rowe fails to recognize that when the root cause is insufficient infrastructure or insufficient government borrowing-and-spending or insufficient risking duration transformation by financial intermediaries that expansionary monetary policy is not the first-best fix, then I do have a quarrel…